By Marius Kilian – 2IP
We don’t like uncertainty. War and politics introduce uncertainty that affects us. The discomfort caused by this uncertainty could lead us to make poor investment decisions that do not serve our personal interest. Let’s reflect and consider the true impact of war and politics on the markets based on the evidence of history.
The effect Wars have on the Stock Market
Wars fought on foreign territory tend to be mildly positive for economic growth, whereas wars fought on domestic soil quickly destroy the economy. For a country that is mired in a war on its territory, the costs are severe. War in your own country has dire consequences and impacts GDP in a big way.
Wars over the past 7 decades were fought in smaller countries and not between industrialised countries. If you were invested in any of these smaller countries, you would have been affected by the impact of war. If not, war was a non-event from a market perspective.
Russia-Ukraine war is being fought on Ukrainian soil and will have a detrimental effect on their infrastructure and economy. The Russian economy accounts for just 1.7% of the global GDP but it is the second-largest oil exporter in the world. Both the European economies’ energy needs, and North Africa’s food shortage are being indirectly impacted by this conflict which contributes to rising inflation. This conflict adds pressure on energy prices that feeds into global inflation. This conflict is also not isolated from the current geopolitical fault lines that are unfolding.
If one looks at the US, counterintuitively the markets have outperformed its long-term average at a lower volatility. Only during the Vietnam war did the market underperform its long-term historic average. Even so, it still outperformed bonds and cash.
Bottom line – tampering with your long-term asset allocation due to the fear of war has been a bad decision historically.
Politics
There’s a complicated relationship between political conditions and the stock market. When considering whether politics impacts the market, it is important to differentiate between short-term and long-term effects.
Politics typically has an indirect effect on the markets, and it tends to be more short term in nature. Markets do not like uncertainty and political uncertainty has an impact on markets, but this is usually short-term.
It is clear that the market returns cannot be explained by what happened in the political arena. The transition of political power in the 1990’s was a historically significant event. The “lost decade” of state capture under Jacob Zuma hiring and firing ministers “at will” does not show up in the long-term trajectory of the numbers.
It did cause short-term pain and discomfort, but the markets and investors responded to the profitability of the underlying companies that makes up “the market”. These companies are managed by professionally qualified executives in a supposedly free market environment.
The only time politics will affect markets is when they alter the economic landscape where companies are doing business. The concerns and questions in the South African context refer to the long-term effects of government policy on the economy. Remember that popularity of politicians is determined by the state of the economy. Politicians from all the key political parties are well aware of this.
Bottom line – until the politics materially change the way companies are doing business, investors need to put the drama on the back burner. Corporate earnings, not politics, drive the market. If companies keep growing their profits, markets will follow. If investors keep the bigger picture in mind, they will be able to weather fluctuations due to political events.
Geopolitics
It is generally expected that geopolitical uncertainty will impact the stock market negatively. Geopolitical competition ranges from energy, natural resources, data and cyber security to aspects such as climate change. How these conflicts resolve themselves and the effect on economic variables have potential consequences for markets and market prices.
The two major investment narratives of the past 2 decades were geopolitical in nature. The Covid-19 pandemic is not in itself a geopolitical event, but it has accelerated the tensions between the United States and China. The political and eco¬nomic relationship between the two countries is arguably worse today than it has been in the past 20 years.
An example of geo-economics is the use of economic power by both China and the United States to impose international rules and standards on other nations. This prospect of rising Chinese influence in emerging economies and increasingly also in Western Europe has led to some irritation in the United States and other countries as China’s BRI investments have come closer and closer to Western Europe and North America.
China’s emergence as a great power undercuts the eco¬nomic influence of Western countries and reduces the profits of Western businesses. No country feels more threatened by the rise of China than the United States because the latter has been the sole leader of the global econ¬omy and promoted liberal democracy and a neoliberal economic model for the past three decades.
The election of Donald Trump as President of the United States led to a significant change in both the foreign and domestic US policies. This has led to the trade war between the US and China. In 2018 the USA started with tariffs on specific items from China that escalated until it caused tariffs of 25% and higher to be imposed on virtually all Chinese imports to the United States and an equivalent number of tariffs on Chinese imports from the United States.
The impact of the trade war has been relatively small thus far. Most countries in the world did not get involved whenever possible. Today, the era of globalization of the past 30 years seems to be coming to an end. Nationalism is on the rise, and geopolitical and geo-economic risks increasingly take centre stage.
Investors need to be mindful of geopolitical trends as a driving force that affect markets. In the long term there is an interplay between geopolitics and markets. Geopolitical events can affect the valuation of financial assets.
Bottom line – The unfolding of geopolitical events usually has long cycles and markets have proven to be highly adaptable after initial shocks. History shows that markets are agile and recover in a very short space of time. In the USA the market recovers within a month on average after geopolitical shocks. Even with the market’s inevitable ups and downs, it has generally offered the best return.
Conclusion
History being our guide it has always been wise to stick to your long-term plan. Investor behaviour is paramount, and it is important to tune out the noise of war and politics. It does not have a long-term effect on a disciplined investors outcome.
I do believe it could be relevant should a war break out on our own soil, or the government destroys the structure of the economy to the extent that it becomes impossible for business to forge ahead. Politicians have thus far been unable to derail our economy. The commitment of business and tenacity of South Africans in general provide hope against this backdrop.
For any further information, please contact us on 031 832 4555 or via email on admin@stonewm.co.za